Debtor Fears Overlook Role of the Dollar

Has investment banker Felix Rohatyn, a possible Democratic secretary of the Treasury, been in outer space? Writing in the New York Review of Books, he says that the United States has lost its economic independence because we have become the world’s largest debtor nation. Gosh, it’s hardly such a watershed. Our economic independence has been eroding for decades. Remember the gasoline lines of the 1970s? We still import two-fifths of our oil. American farmers and manufacturers depend heavily on overseas markets.

But Rohatyn is in good company. Few subjects have inspired as much economic hysteria and confusion as America’s emergence as a “debtor nation.” We’re compared with Brazil and Mexico. Americans, it is said, will suffer a prolonged drop in living standards as we repay our huge foreign debts through large trade surpluses. Writing in Foreign Affairs, analyst Robert Reich of Harvard says that our debtor status signifies a “decline in our capacity to add value to the world economy”--a phrase as ominous as it is empty.

What is generally meant by our becoming a debtor nation is that our huge trade deficits are causing foreigners to hold more dollars than they owe us. But comparisons with the Third World debtor nations are strained. Mexico suffers because it owes dollars to foreign banks that can be repaid only by earning the dollars through exports. This situation doesn’t apply to the United States because the dollar is the major international currency. We can service our debts and pay for our imports with our own currency.

A more plausible threat to U.S. living standards is a depreciating dollar. Our exports become cheaper while imports become more expensive. We sell more abroad and buy less. Indeed, the dollar’s 45% decline since early 1985 has already started to reduce the U.S. trade deficit.

But this change hardly portends a collapse of American living standards. What primarily raises living standards is increased productivity--how much more efficient our economy becomes.

Contrary to what Reich says, we do add value to our economy and to the world’s. Between 1980 and 1986, productivity rose at an annual rate of 1.6%--more than double the 0.6% average of the late 1970s. This means that the elimination of our trade deficits represents a small burden on future living standards. Our gross national product totals $4.5 trillion. On paper we could end trade deficits by exporting the equivalent of two years’ productivity gains. (A 1.6% increase of $4.5 trillion is nearly $75 billion, about half the current trade deficit.) Of course, the trade deficit won’t drop so mechanically. Any change will take longer. But this arithmetic shows that ending the trade deficits won’t by itself impoverish Americans. If productivity gains continue--a big if--few Americans will notice a change.

Contrary to popular wisdom, Americans for decades have spent more abroad than we have earned. Until the 1970s the excess spending went for military programs, foreign aid and overseas investment. Now it goes for imports. In general, the world welcomed the dollar outflows. Other countries accepted dollars to finance their trade. Multinational companies used dollars to expand. Wealthy individuals made dollar investments as a hedge against the instability of their own currencies. But when dollar outflows became too great, periodic financial crises resulted.

It’s precisely the dollar’s special global role that confounds the measurement and meaning of our status as a global debtor. What’s happening now is that the world is being flooded with too many dollars. The greatest danger is another crisis of confidence, warns economist Shafiqul Islam of the Council on Foreign Relations. A flight from the dollar could cause a sharp depreciation, which might hurt both the economy of the United States and those of other countries. Higher import prices could raise inflation, triggering a U.S. recession that would spread to other countries.

Rohatyn wants us to restore our economic “independence.” The phrase sounds good, but it’s meaningless. The United States can’t extricate itself from the world economy. Consider our present predicament. What’s needed now is stronger economic growth in other countries, allowing the United States to continue an export-led expansion. This shift would slow the outflow of dollars and avoid a global recession.

The paradox is this: An expanding world economy needs a reasonably stable dollar, but a stable dollar may be impossible without an expanding world economy. For Americans, the dollar’s instability creates its own troubles. If today’s danger is excessive dollar depreciation, the problem of the early 1980s was just the opposite. The dollar’s rapid rise devastated U.S. industries and farmers by making their exports less competitive.

So we need to temper these violent exchange-rate movements. One way is to control inflation, which affects confidence in the currency. Other needed steps aren’t so clear. No one fully understands the quirks of the foreign-exchange markets. But the United States can’t solve these problems alone. The quest for “independence” is a fantasy. Our real problem is finding ways to advance our national interests in an interdependent world.